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Are Incentive Contracts Rigged by Powerful CEOs?





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    • Morse and Seru are with the Booth School of Business, University of Chicago, and Nanda is with the Georgia Institute of Technology, College of Management. We thank Lawrence Brown, Robert Bushman, Daniel Ferreira, Yaniv Grinstein, Campbell Harvey (the Editor), Charles Hadlock, Steve Kaplan, Joshua Rauh, Morten Sorensen, Anjan Thakor, the Associate Editor, an anonymous referee, and seminar participants at Arizona State, Alabama, Chicago GSB, Georgia State, Georgia Tech, Michigan, Vienna, Washington St. Louis (Olin), The American Finance Association 2006 meetings, The European Finance Association 2006 meetings, and the Financial Economics and Accounting conference at the University of North Carolina for their helpful comments and suggestions. We are responsible for all the errors.


We argue that some powerful CEOs induce boards to shift the weight on performance measures toward the better performing measures, thereby rigging incentive pay. A simple model formalizes this intuition and gives an explicit structural form on the rigged incentive portion of CEO wage function. Using U.S. data, we find support for the model's predictions: rigging accounts for at least 10% of the compensation to performance sensitivity and it increases with CEO human capital and firm volatility. Moreover, a firm with rigged incentive pay that is one standard deviation above the mean faces a subsequent decrease of 4.8% in firm value and 7.5% in operating return on assets.